WARNING: What you learn here may disturb your beliefs.
Money influences every human in developed countries from birth to death. It is the one subject that transcends age, race, sex, religion, politics, or any other devisive human influence. Yet, far too few people understand the origin of money or the influence money has over their lives. How much time is devoted to getting money? How many family "values" are subverted such as abandonment of children to day care so parents can spend their time getting money?
There is an enormous amount of literature devoted to getting money. The getting of money is usually expressed as "making money." As we shall see, "making money" is a semantic and literal fallacy.
Various information media through financial journalism and advertising offer advice about how to "make money."
Where does the money that is the subject of so much advice on how to "make" come from? How is it actually made so that it is available to "make"? From here on the word create will be used to distinguish the actual making, that is the creation of money, from the semantic fallacy, "making money."
What are the effects of how money is created?
Where can one find out?
Information presented here will help answer the above questions.
Money is created by the loan making activity of banks. Original bank reserves are created and uncreated by actions of the Federal Reserve by buying and selling, primarily, U. S. Treasury Securities in the open market. The Federal Reserve does not use its own money or anyone else's money to purchase securities. The Fed creates a deposit by check or computer entry that is credited in a commercial bank deposit account. At the same time, the Fed credits the commercial bank’s reserve account with the same amount. In short, it creates the money out of its legally endowed power of doing so.
Commercial banks use the reserve deposit as the basis on which they make loans. The commercial banks expand reserve deposit money by a procedure known as fractional reserve deposit expansion. By this procedure, commercial banks may expand original reserves by ten times or more. The following is an excerpt from FEDPOINT45:
Reserve Requirements and Money Creation
Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, reduced economic activity.
The Fed uncreates money by selling securities and canceling previously created deposits. Commercial banks must follow and contract their deposit expansion.
The total of money in circulation is the sum of this complex activity.
A detailed explanation of deposit creation and expansion can be found in a thirty-eight page booklet, Modern Money Mechanics, obtainable from the Federal Reserve Bank of Chicago. The booklet is free and can be ordered from FRB of Chicago Public Information Center, P. O. Box 834, Chicago, Il 60690-0834.
Money is put in circulation when banks make loans, and money is taken out of circulation when loans are repaid.
Some money is coined by the U. S. Treasury and deposited for credit in Federal Reserve banks. Federal Reserve banks issue Federal Reserve Notes (paper money) to commercial banks for the convenience of bank customers who prefer paper notes to paper checks. Coins and notes account for a minor part of economic exchange.
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